Should We Be Worried About Interest Rates?

Sep. 10, 2019 2:18 PM ET2 Comments
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Specializing in economics, Macro, Portfolio Strategy, Bonds

Contributor Since 2017

Eric Basmajian is an economic cycle analyst and the Founder of EPB Macro Research, an economics-based research firm focusing on inflection points in economic growth and the impact on asset prices.

Prior to EPB Macro Research, Eric worked on the buy-side of the financial sector as an analyst at Panorama Partners, a quantitative hedge fund specializing in equity derivatives. 

Eric holds a Bachelor’s degree in economics from New York University.

EPB Macro Research offers premium economic cycle research on Seeking Alpha. 

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Should We Be Worried About Interest Rates?

One of the reports published to members of EPB Macro Research is the [Weekly Macro Theme] report, where we take a deeper dive into trends, moves in the market, or changes in the economic data. This week, we discussed the move higher in interest rates, what's causing the move and what we should be looking at going forward. 

Below is an excerpt from today's report. To read the full report, click this link for a no-risk 14 day Free Trial

Rising Rates

Now that we understand the context of the decline in final sales, let's look at the reasons behind the rapid rise in interest rates or the sharp decline in ETFs TLT and EDV.

Over the past week, Fed Funds futures are showing that the market reduced monetary easing expectations and now anticipate roughly 25bps fewer rate cuts.

1 Week Change In Fed Funds Futures:

Source: Bloomberg, EPB Macro Research

Let's look at this change another way. The following chart shows the expected Fed Funds rate two years in the future. For example, the reading of 1.03% implies that two years from today, the market expects the policy rate in the US to decline from its current reading of 2.13% to 1.03%, about 110bps of rate cuts over the next two years.

2-Year Forward Market Implied Policy Rate:

Source: Bloomberg, EPB Macro Research

Just a few days ago, the market was expecting the Federal Reserve to lower the policy rate to 0.79% over the next two years. So to simplify, over the course of several days, the market now expects about one less rate cut over the next two years.

This change in expectations caused the entire Treasury curve to move higher by roughly that 25bps.

The market may expect fewer rate cuts for many reasons including higher growth expectations, and a more optimistic view of trade relations which may cause the Fed to believe the economy will re-accelerate.

On top of reducing the amount of monetary easing that is expected, inflation expectations rose slightly. The 10-year breakeven rate is up about 8bps since last Tuesday.

Inflation expectations have not moved much relative to real rates. This move in interest rates is coming from real rates and reduced expectations of monetary easing.

10-Year Breakeven Rate (%):

Source: Bloomberg, EPB Macro Research

If Treasury rates continue rising, it will likely come from two places, reduced monetary easing expectations (fewer rate cuts) or increased inflation expectations.

While this note is not meant to dive into all the leading indicators of inflation and growth, we can take a look at one of each.

To read this week's full [Weekly Macro Theme] report, click the link below.

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